How to Protect Your Bitcoin Business from Regulators

Mike Gropp is the co-founder of the BitBays Bitcoin exchange and is in charge of the company’s compliance to the ever-changing landscape of cryptocurrency law.

After working in the financial sector in California, Mike moved to Beijing in 2010 where he launched his own corporate training company focusing on sales, professional speaking, and negotiations. While expanding his business, Mike taught undergraduate business courses at Beijing University of Chemical Technology in the prestigious IBC (International Business Curriculum) Program.

“Different companies have different legal strategies,” said Mike to Cointelegraph via email. “Right now there are a lot of companies in the gray or so they think. They will send letters asking for clarification of their status whilst operating as an illegal money transmitter […] also, asking for a ruling while operating illegally doesn't cover one legally.”

We would like to thanks Mike for timely sharing his advice regarding regulatory compliance in light of the US regulators’ moves earlier this week when FinCEN and the SEC issued a pair of guidance documents and allegedly sent out secret requests to several Bitcoin companies, respectively.

Cointelegraph: What is you background as far as regulatory compliance is concerned?

Mike Gropp: I'm apart of the Association of Certified Fraud Examiners. Fraud Examiners investigate financial fraud from petty cash skimming and larceny up to financial statement fraud where liabilities are understated or revenues are overstated in the millions (like the Enron and WorldCom scandals.) I'm also a Co-Founder of BitBays.com, a Bitcoin exchange, and I’m handling our compliance and risk programs.

CT: What are the relevant regulatory bodies where one must register in the US?

MG: For an exchange or payment processor one would need to register with FinCEN as a Money Service Business. Also, 48 out of the 50 states require money transmitter licensing at the state level. The names of these regulatory bodies vary slightly. In Hawaii it's the Division of Financial Institutions. In North Carolina it's the Commissioner of Banks. If one wants to offer securities they should contact the SEC. Lastly, let's not forget the IRS because they certainly wouldn't forget you...

“Payment processors and exchanges with US clients should immediately go to FinCEN.gov and register as an MSB.

“The real challenge is registering at the state level, which must be done in every state one wishes to operate as a money transmitter.”

- Mike Gropp

CT: What steps should a US-based exchange or payment processor take right now to be compliant with FinCEN, the IRS and the SEC? What does it actually mean to be "fully compliant"?

MG: Whether one is a US-based exchange or not doesn't decide whether one needs to register. The question is whether a company has clients in the US or not. If so, they are subject to regulations of that jurisdiction.

Payment processors and exchanges with US clients should immediately go to FinCEN.gov and register as an MSB. This is quite simple. The real work is ongoing reporting: CTR (Currency Transaction Reports) and SAR (Suspicious Activity Reports).

The real challenge is registering at the state level, which must be done in every state one wishes to operate as a money transmitter. It's not a simple registration. It's an investigation into one's company to determine if a license will be given. This includes producing audited financial statements, being subject to background checks, and more. It could take as long as a year or more.

Furthermore, the fees range from US$100 to US$5,000 per state. There are also ongoing financial obligations. One is a net worth requirement of US$1,000 to US$2,000,000. The other is a surety bond (or equivalent) per each state ranging from US$10,000 to US$2,000,000 with California as an outlier at US$7,000,000.

These bonds cost 2-7% annually to maintain which puts one's licensing expenses over a quarter-million dollars minimum annually from bonds alone. These bonds act as insurance against losing or misappropriating customer funds.

It's not just about being something on paper either. MSBs need serious policies in place to prevent fraud, money laundering, and terrorist financing. MSBs also need strong internal controls and effective employee training for identifying suspicious activity. At the very basic level this includes a KYC (Know Your Customer) policy to verify client identities. This not only reduces one's legal risk by preventing organized crime and terrorist organizations from using one's platform, but it also reduces financial fraud. It's not just a legal responsibility, it makes financial sense.

As far as the IRS, registering as an FFI (Foreign Financial Institution) to be FATCA (Foreign Account Tax Compliant Act) compliant is similar to registering with FinCEN. Doing so is easy, but one most give ongoing reports of US client transactions and account balances. The IRS isn't necessarily looking for taxes from the FFI, but rather to ensure US citizens aren't using the FFI to evade taxes.

“BTC companies operating as unregistered money transmitters face civil penalties of US$5,000 per day, and criminal penalties up to 5 years in jail.”

- Mike Gropp

CT: Tell us about the penalties companies that have allegedly received SEC letters in the past week could potentially be facing. What about being an MSB - What are the consequences of not registering or being compliant?

MG: There are two issues at hand. One is operating as an unregistered broker-dealer. The other is selling unregistered securities. Here's one example. Last year a company out of Cyprus, Banc de Binary, selling binary options online operated as an unregistered broker-dealer selling unregistered securities. They were assessed civil penalties including forfeiture of profits and an injunction barring them from accepting US clients.

BTC companies operating as unregistered broker-dealers offering unregistered securities could be forced to forfeit profits, pay hefty fines, and get blacklisted from accepting US clients in the future. BTC companies operating as unregistered money transmitters face civil penalties of US$5,000 per day, and criminal penalties up to 5 years in jail.

According to 2011 FinCEN definition, money transmission includes fiat or digital currencies. A crypto-only exchange is still considered a money transmitter by this definition. Also, there are no thresholds. Any amount of bitcoins or fiat transmitted from one person to another by a third-party is considered money transmission.

Companies, such as OKCoin, are using thresholds intended for other types of MSBs, such a prepaid access. If anything I hope this interview abolishes the myth that avoiding fiat or enforcing daily thresholds exempts one from money transmitter licensing.

“If anything I hope this interview abolishes the myth that avoiding fiat or enforcing daily thresholds exempts one from money transmitter licensing.”

- Mike Gropp

CT: Are there extra requirements or benefits for being a local or international company?

MG: Local US companies pay taxes to the IRS. International companies have to work with the IRS to stop US clients from evading taxes.

CT: Aren’t there some ‘safe haven’ jurisdictions such as Belize where companies could register without jumping through so many regulatory hoops?

MG: Once again, it's all about where your clients are and what your legal strategy may be. If you have clients in the US, be compliant in the US. Our strategy at BitBays is quite conservative: register where necessary, meet the highest compliance requirements, follow best practices, and streamline our reporting to the various agencies from country to country where reporting is required.

Some companies may look into registering their domain in obscure places under pseudonyms, keep operations decentralized or in 'safe havens,' even being versed in local extradition laws. This is another extreme. The Bitcoin ecosystem will have both.

“The current gray is going to get black and white real fast.”

- Mike Gropp

CT: How do you think these regulations will affect the market?

MG: Regulatory bodies are beginning to make their presence felt in a tangible way. Some companies will face civil penalties; this burden may sink a few companies. Many will say parley, and a few will raise the black flag with cross bones and sail on to darker waters. The current gray is going to get black and white real fast.

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